CFO insight and analysis written and compiled by DeloitteCONTENT FROM OUR SPONSORPlease note: The Wall Street Journal News Department was not involved in the creation of the content below.

Text Size

Regular

Medium

Large

Google+

Print

Value Killers: What You Can Do to Understand and Prepare for Them

The last decade saw a number of events, from the global financial downturn to the euro crisis and the disruptive floods in Thailand, that impacted the shares of individual companies and at times whole markets. For some companies such events were value killers, creating significant losses, and not all were fortunate enough to rebound.

Edward Hida, Partner, Deloitte & Touch LLP

In The Value Killers Revisted: A Risk Management Studyfrom Deloitte LLP, authors Dr. Ajit Kambil, global research director for Deloitte’s CFO Program, and Edward T. Hida II, a partner at Deloitte & Touche LLP, and global leader of Risk and Capital Management, analyzed the 1,000 largest global public companies for the period 2003 to 2012. Utilizing more than two million financial data points over 10 years, they calculated the magnitude of each company’s largest one-month loss (“loss event”). They then analyzed hundreds of articles and reports on these loss events to understand the reasons for the 142 most severe drops in company value (to identify 100 company names). The latest study, which builds on an earlier study that tracked losses in shareholder value from 1994 and 2003, also identified the value killers behind these major losses, as well as insights about key value killers.

“Our recent study showed that since 2003, almost 38% of these companies suffered share-price declines of more than 20% in a one-month period relative to the MSCI Global 1000 index in the same period. We call these dramatic losses ‘value-killer losses,’” says Dr. Kambil. “We also found that by the end of 2012, roughly 18% of these companies had not yet recovered their value-killer losses, while 18% waited over a year for their share prices to recover. And only 6% of the companies analyzed had a value loss relative to the MSCI index of less than 10% over the decade,” he adds.

Although many of the value-killer losses were concentrated in the finance, insurance, construction and raw-materials industries, the study found value-killer losses were prevalent across a wide range of industries. “Moreover, the individual value-killer events, while distinct, were often driven by similar underlying risks,” says Mr. Hida.

Dr. Ajit Kambil, Global Research Director, Deloitte CFO Program

One example of the damage a value killer event—or combination of events—can cause organizations involves a large company that confronted declining demand and prices for its products a few years ago and could not meet prior business-plan forecasts. The company reduced its go-forward revenue expectations, and had to initiate a restructuring of its operations and reductions in its workforce to focus on strengthening the balance sheet. On top of this, the company also announced that it would record material impairment charges. These factors, in turn, motivated a credit-rating agency to downgrade the company’s rating, citing the above factors. All of this led to a drop in share value of more than 40% within a few weeks.

“Value-killer losses often result from the interaction of a number of unpredictable factors and are rarely the outcome of just one issue,” says Mr. Hida. “When we analyzed the largest losses, almost 90% of companies were hurt by several risks working in concert even if triggered by a specific event,” he adds. “In other words, when bad things happen, they may occur as an unexpected bundle of correlated or uncorrelated events that add up to a significant value-killer loss.”

Top Drivers of Value Killer Share Declines

In all, the authors observed five major themes underlying the value killer losses:

1. High-impact, low-frequency risks trigger most value killers: The most notable trigger of value-killer risks was a high-impact, low-frequency event, often referred to as a black swan. Large industry- or economy-wide events such as the credit crisis or eurozone crisis drove the most value losses. These events often expose a company’s biggest strategic, operational or financial weakness, often triggering a further cascade of negative events for the company.

2. Correlated and interdependent risks. The study reveals nearly three-fourths of major loss events occurred due to correlated and interdependent risks. While a black-swan event may trigger a value loss, its magnitude is often amplified by interdependencies among a variety of risks in an organization. Interdependent risks were the key driver of value losses in the first report; the authors’ latest research reaffirms the importance of thinking about risk events not just in isolation but in terms of how a risk event may trigger other events within a company and escalate into a massive value loss. During this time the term “systemic risk” entered the broader lexicon as many companies in the financial services sector stood on the brink of collapse. Interdependencies between the financial-services industry, and other industries and companies dependent on financial services, made it critical to consider how the events and risks outside a company’s core industry–but still within its ecosystem of critical resources–can drive value.

3. Liquidity risk became more salient: The financial downturn made real or perceived weaknesses in a company’s balance sheet, and the potential inability to access capital, a much more salient driver of value losses. Since the financial downturn, highly leveraged companies without sufficient liquidity reserves were at greater risk of value loss than comparable firms with less leverage. In the face of rising costs and slowing demand, lack of liquidity was often a critical constraint on the company and a driver of value losses.

4. Unsuccessful M&A remained a critical value killer for select companies: As was found in the earlier study, unsuccessful M&A deals can be value killers for many different reasons. Deals can go bad due to incorrect valuations before the deal, failure to complete an announced deal, changed economic circumstances after the deal, or failure to capture anticipated synergies or effectively execute post-merger integration.

5. Culture, compensation and fraud risks as drivers of value losses: These risks arise when a company’s culture and compensation plans create incentives to commit fraud or encourage employee behaviors that increase the risks that are assumed by a company.

In addition to the above findings, the study revealed a few other categories of salient risks that drove value killer-like losses. These include cost overruns and political and sovereign policy risks. Lastly, one noteworthy finding was that instances of accounting fraud as a driver of value-killer losses–at the 100 companies that experienced the largest value-killer losses–was substantially lower this decade than in the previous decade.

Guarding Against Value Killers

While risks cannot be eliminated, companies can better prepare for them. Scenarios and models can be built to explore how companies will fare when confronted with a value-killer event, especially, high-impact, low-frequency events. Companies can stress-test their capacity to respond to different scenarios where a bundle of events—correlated or uncorrelated—occur concurrently. A risk-intelligent enterprise can build on the knowledge of prior value-killer risks to help identify, model and practice ways to manage and respond to existing and future value-killer risks.

“Scrutinizing value killers and pathways to losses can help frame better questions on how to sidestep or manage future risk events,” says Dr. Kambil. “While new surprises are always lurking around the corner, and the past is not necessarily a prelude to the future, by understanding the past we can more likely avoid repeating its mistakes.”

Related Deloitte Insights

When large North American company CFOs participating in Deloitte’s latest CFO Signals™ survey were asked about megatrends that are most impacting their longer-term business strategy, more than half indicated data analytics and convergence/disruption. “Clearly, those two factors are top of mind for CFOs of large organizations,” notes Sandy Cockrell III, national managing partner of the U.S. CFO Program, Deloitte LLP, “and I expect they could have an impact on decisions on investments, talent and other areas.”

New executives are usually brought in as catalysts for change at their new organizations. But launching change initiatives is fraught with execution risks that range from a paucity of resources to potentially poor stakeholder alignment to emotional and social resistance—the so-called Wheel of Woe execution issues. Learn about the 12 issues, including talent, data and systems, governance and stakeholder commitment, that pose key execution risks and insights into how to address each.

The analytics used by many companies rely on two-dimensional reports featuring a significant amount of words and numbers to facilitate a discussion or communicate a point. But in many cases, the information lends itself to more questions, requiring iterative versions to provide the answers. Visual analytics is an effective way to convey data, particularly cost data, to management and support strategic decision-making. Such tools and techniques also make complex data transparent and accessible to users, regardless of their background or skillset.

Views & Analysis

Congress passed the first major tax reform legislation since the 1980s, bringing sweeping changes that will impact life sciences and health care organizations and their executives’ business decisions in 2018 and beyond. David Green, partner, Life Sciences and Healthcare Industry leader, Deloitte Tax LLP, discusses the new tax law and its potential implications across the health care industry—from biopharma and medtech companies to health plans and not-for-profit hospitals and providers.

Now that Congress has passed tax reform, CFOs and their tax teams face the challenge of understanding and preparing for sweeping changes ushered in by the new law. The transition to territoriality, new rules regarding passive and mobile income, and many other provisions will require careful assessment and planning. “While the broad-based bill ushers in substantial changes, companies may find it particularly challenging to assess the many ways in which the law’s provisions affect international operations,” says Steve Kimble, chairman and CEO, Deloitte Tax LLP. Learn more about the scope and implications of some of the most notable provisions of the new law that impact international operations.

The tax reform legislation introduces new rules aimed at providing greater parity between the tax rates applicable to owners of passthrough entities and corporations by providing a 20% deduction for qualified business income. The potential tax scenario for passthrough entities depends on the operations of the organization, the make-up of its ownership and where it does business. Implementing the new legislation will require a focus on business considerations, as well as tax issues.

Editor's Choice

Commercial real estate (CRE) could benefit by using blockchain for property transactions processes involving leasing, purchasing and sales, according to a Deloitte Center for Financial Services report. The report identifies how blockchain could improve property transactions processes, including more transparent and more cost-effective property title management. “CRE CFOs evaluating an upgrade or overhaul of their technology platforms should have blockchain on their radar,” says Bob O’Brien, Global Real Estate & Construction leader, Deloitte & Touche LLP.

Millennials have often been unfairly characterized as valuing passion over performance and fulfillment over hard work, all while expecting the corner office. But do these stereotypes hold up? To find out, Deloitte LLP conducted a study based on Business Chemistry®, a behavioral assessment framework that matches individuals to one (and sometimes two) of four types: Pioneers, Drivers, Guardians and Integrators. The results might surprise senior executives; more importantly, the study may help leaders glean new insights into how to effectively manage millennials.

In 2016 MetLife spun off a substantial portion of its U.S. retail segment as Brighthouse Financial. Anant Bhalla was tapped to become the new company’s first CFO, bringing to the position experience in finance and treasury, as well as in risk management, corporate strategy and product management. Mr. Bhalla offers lessons for CFOs that may apply not only to spin-offs but also to other complex transactions, in this conversation with Gary Shaw, vice chairman and U.S. insurance leader, Deloitte & Touche LLP, and John England, senior partner, audit and assurance, Deloitte & Touche LLP.

About Deloitte Insights

Deloitte’s Insights for CFOs provides financial executives a customized resource to help them address the strategic, operational and regulatory issues they face in managing their finance organizations and careers, with top-line digests, research, perspectives and technical analyses.